Foreign exchange rates or Forex , change all the time, and what can seem like a good rate can disappear within days. Canada seemed cheap! However, fast forward ten years to , and 1 GBP now only buys 1. This makes my still necessary trips to North America much more expensive, and things no longer seem like a bargain.
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This means I have to keep a much closer eye on the exchange rate in order to balance my budget. But how do I know this? The first step is to locate historical exchange rates. There are many websites that give you this data for any two currencies. I like Oanda. But there are three more lines on the chart. Bollinger Bands are equivalent to the day moving average plus or minus two standard deviations. Similar to the stock market, there are times in which Forex rates change rapidly. This is known as volatility. During periods of volatility the Bollinger bands move further apart, and vice-versa when the market is stable.
Now, some professional forex traders have drawn the conclusion that bands that get narrower indicate that the market will become more volatile in the future, while bands that get wider mean that the market will become less volatile in the future.
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This allows them to make instant trading decisions, taking advantage of small pricing movements. Another useful indicator is the Bollinger Squeeze. Bollinger bands are remarkably easy to create in Excel. The calculation of the lower band is almost identical, but the same number of standard deviations is being subtracted to shift down the band. If you are unfamiliar with the concept, keep on reading.
If the price frequently deviates away from the mean to a significant degree, the asset is considered to be volatile. In other words, the standard deviation is the measurement of volatility , which, in turn, is used to measure the riskiness of an investment. The standard deviation can be calculated for a sample or the entire dataset population. The set of numbers is given by the close prices and the mean is given by the middle band. We can rename the variables in the formula accordingly, and this yields the formula that we use in the calculation of the upper and lower bands.
First, you subtract the average of the closing prices the middle band from each closing price. This will give you a list containing the deviations from the mean — both positive and negative. For that, you must sum the list and divide it by the number of items n. At this point, you might notice that while the negative signs are cancelled, we magnified the positive deviations. As always, you must start by downloading some data. Fortunately, Excel has built-in functions for practically everything we need to calculate, so it will be a piece of cake.
Remember that the purpose of the middle band is to provide some measure of central tendency. Calculating a day SMA is indeed simple: You must add together the closing prices over the day period and divide the sum by The correspondent Excel formula is the STDEVPA , which expects a set of values as its arguments and returns the standard deviation based on the entire population.
Since we have 20 periods again, you must choose the same range as before and place the formula right next to the first SMA value. Bands are the same as the middle band, but they are shifted up or down by the number of standard deviations that you want to use. For the lower band , you take the middle band and subtract two standard deviations. Good job! Luckily, you already have all the data and it takes only a few clicks to turn the boring numbers into the fancy indicator you can see on any trading platform.
Now, if you take a look at the horizontal axis, you have some weird numbers there instead of the dates. So, we already changed the label, but remember that this is only the price chart. For each series, select the respective data range, similar to what you did with the dates, but this time, enter into the Y values section. You might want to do a few minor adjustments to make it easier to interpret the bands. First, change the colors to be the same for the upper and lower bands. You can also change the colors for the entire indicator if you wish. Then, notice that the minimum and maximum values are slightly off from the actual extremes of the indicator.
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You might want to fix this too. Quite the same! Note that the prices you get from Yahoo Finance might be different as quotes slightly vary from broker to broker. As long as your indicator looks similar, you probably did everything correctly. Markets normally move in waves as the price tends to follow an alternating pattern of impulse and consolidation.
In an uptrend, buyers keep raising the price, but from time to time, they bump into a level where supply is strong enough to overcome the buying pressure. This is where the market enters into a consolidation phase. Shorting when the price breaks above the upper band might make sense if you believe that the market is overbought and due for a pullback.
Bollinger Bands Trading Strategy (Backtesting with MarketXLS)
This idea uses the concept of mean reversion, which states that the price will eventually return to the long-run average. Of course, the opposite is true for buying the market if it broke below the lower band and you think a bounce is on the way. Usually, it helps if you look for other confirmation signals such as support and resistance zones or candlestick formations.
For example, below, you can see that the price reaches a major support zone where it crosses the lower band and forms an engulfing pattern. Despite the best efforts, capitalizing on mean reversion can be challenging if the market is trending. Especially on smaller timeframes, unexpected news can quickly spark enthusiasm. You might find yourself in situations where, instead of reversing, the price is repeatedly pressing into the upper or lower band, indicating an extremely strong trend. On one hand, you can try to filter out non-trending conditions and only trade mean reversion techniques when a range is in place.
On the other hand, instead of buying and selling when the market breaks the bands, you might wait until the market returns inside the bands and buy or sell somewhere near the middle band. With this method, you only trade in the direction of the trend, which might not only increase your chances of winning , but you might also benefit from catching a strong trend. He divided these patterns into two categories resembling M and W letters.
Bollinger is a big advocate of using these M and W patterns in his book, Bollinger on Bollinger Bands. M-tops and W-bottoms can be regarded as double tops and double bottoms with a common variation being the head and shoulders and inverted head and shoulders patterns.
As you might already know from our chart patterns guide , double tops are characterized by:. This usually happens when the price breaks through the upper band. Then, the reaction pullback should take the price back inside the bands, ideally near or beyond the middle band 2. The implication of this is that the rally met with strong resistance and the price was pushed back to its normal level.
The second rally should occur without breaking the upper band 3. Once the price breaks below the retracement low, you get a short signal 4. Of course, the opposite is true for the double bottom pattern and similar logic can be applied to other patterns. Lots of people try to capture the breakout. If you want to be one of them, you need to be aware of a few things. The obvious first step is to wait for a consolidation in which the trading range narrows dramatically. According to Bollinger, the Squeeze setup is identified when the volatility reaches a six-month low value.
Bollinger bands
If you trade lower than the daily, you might translate this to a more relevant time period. This is just our suggestion. For example, six weeks for the four-hour chart or something similar if you feel that the six-month low is a bit too much. However, you can also rely on your eyes if you wish.